Friday, October 31, 2014

The “Depression” of 1920–1921: The Libertarian Myth that Won’t Die

Yes, there was a recession from 1920–1921, but its history and significance are badly misrepresented by libertarians and Austrian economists, and the following talk by James Grant is a case in point. Grant even has a forthcoming book on the recession called The Forgotten Depression: 1921: The Crash That Cured Itself (2014).

What are the problems here?

They are as follows:

(1) the downturn of 1920–1921 was not a depression, if “depression” is defined as a contraction in the business cycle where real output fell by 10% or more.

The two best estimates of the depth of the downturn of 1920–1921 are Romer (1989) and Balke and Gordon (1989: 84–85).

Romer (1989) provided a new estimate for GNP declines from 1920 to 1921, as follows:

These estimates show a GNP contraction of only 3.47% from 1919 to 1921, a mild to moderate recession.

By contrast, Balke and Gordon (1989: 84–85) estimate a GNP decline of 5.58% from 1920–1921, a moderately bad recession.

On either of these estimates, however, the downturn of 1920 to 1921 was nothing like the Great Depression, and, as we will see below, was an anomaly in other ways.

(2) Even the idea that the recession of 1920 to 1921 was some remarkably short recession is untrue. The recession lasted from January 1920 to July 1921: a period of 18 months. But a recession lasting 18 months is in fact quite a long one by the standards of the post-1945 US business cycle. The average duration of US recessions in the post-1945 era of classic Keynesian demand management (1945–1980) and the neoliberal era (1980–2010) has been about 11 months (Carbaugh 2010: 248; Knoop 2010: 13). So far from being some remarkably quick recession that was shorter than post-1945 recessions, it was about 7 months longer than the post-1945 average.

(3) At 12.29–12.33, Grant says that the recession of 1920 to 1921 was “the last governmentally unmediated major business cycle downturn.” This is untrue. Why? Because the Federal Reserve existed, and engaged in both open market operations and interest rate reductions as a deliberate strategy to stimulate recovery. In particular, by April and May 1921, the Federal Reserve member banks dropped their rates to 6.5% or 6%. In November 1921, there were further falls in discount rates: rates fell to 4.5% in the Boston, Philadelphia, New York, and to 5% or 5.5% in other reserve banks (D’Arista 1994: 62).

From the perspective of libertarian ideologues, it was worse than this, because other government interventions occurred as follows:

(1) a proto-form of quantitative easing by the Federal Reserve in which there were open market operations in late 1921–1922 to aid recovery, and in which the Federal Reserve bought government bonds from November 1921 to June 1922 and tripled its holdings from $193 million in October 1921 to $603 million by May 1922 (a fact even noted by Rothbard 2000: 133).

(2) direct credit allocation by the government “War Finance Corporation” and the “Federal Land Bank system” from early 1921, in which loans were granted to distressed farm cooperatives and other agricultural businesses. In August 1921, the War Finance Corporation corporation even became a rediscount agency for agricultural and livestock producers.

(3) there was even some limited deficit-financed public works, in the form of municipal bonds.

What should be particularly embarrassing for libertarians and Austrians is that all these interventions were known to and described by Rothbard (see Rothbard 2000: 137–138, 191–193).

(4) Running through the talk is the bizarre background assumption that Keynesian economics says that economies can never recovery from recessions without government intervention. But that is not what Keynes or Keynesians think. What Keynes thought was that there is no universal, consistent, and reliable tendency for market economies to converge to full employment equilibrium. This does not mean that market economies can sometimes recover relatively rapidly from recessions, under the right circumstances.

(5) There were a number of reasons why the recession of 1920–1921 was unusual and indeed anomalous, and why it did not become very severe and protracted:

(1) the deflation was caused to some great extent, not by demand shocks, but a positive supply shocks in commodities due to the resumption of shipping and production after WWI (Romer 1988: 110; Vernon 1991).

(2) the recession of 1920–1921 also had no serious financial crisis, and no mass bank runs and collapses;

In short, 1920 to 1921 was an anomalous recession, it was not especially short, it did have monetary interventions that aided recovery, and it is absurd to think that you can make sweeping generalisations from it about how government interventions are never needed to stabilise economies.

8 comments:

The reason these myths don't die is because the right-wing libertarian 'movement' is not a truth or fact-based movement. Right-wing 'libertarianism' isn't even a genuine or coherent political ideology, really. It's more a form of personality disorder sustained by a constant stream of deceitful propaganda.

Actually I think Murphy is turning into Joseph Smith. I'll see if I can organize a post on what I mean and why. But he really seems to believe his intuitions are infallible, like the voice of god thing or the rocking horse. Most people accept that when distracted the mind plays tricks. Not Murphy, he simply cannot imagine he is wrong about these, truly cannot. Murphy is so sure he is right it leads him to even reject biology.

Yes, that video is part of what I mean by the Joseph Smith idea. This is prophecy not reason.

I liked this comment from Tel"LK simply cannot find an example of market failure that was caused by micro decisions. The so called “Tragedy of Thrift” is a crock. There’s no evidence of such a thing happening."

Zowie. Tel is not in any sense an idiot. He is not some Roddis wannabe.But this just shows how ideology clouds thought.